Dr Pelin Demirel, Dyson School of Design Engineering, Imperial College London
Dr Thomas Wainwright, School of Business and Management, Royal Holloway, University of London
Tags: Proptech, net zero, carbon, data standards
Output type: Research briefing
Target stakeholders: Institutional investors, developers, landlords, government
"Orbiting Carbon Observatory-2” by NASA HQ PHOTO is licensed under Attribution-NonCommercial-NoDerivs 2.0 Generic
What’s the issue?
Sustainability in business is not particularly new. Socially Responsible Investment (SRI) funds emerged in the 1970s to avoid ‘sin’ stocks, but only relatively recently have property investors become more interested in the Environmental, Social and Governance (ESG) characteristics of their assets: their environmental impact (think carbon), social sustainability and effectiveness of governance. Interest in net zero carbon continued to grow in the recent build-up to COP26, alongside the United Nation’s Sustainable Development Goals (UNSDGs), many of which are relevant to real estate. More sector specific initiatives such as the World Green Building Council’s Net Zero Carbon Buildings Commitment, have focussed on the sector’s decarbonisation. What is perhaps most surprising has been the substantial growth of interest in just a few short years. While architects and innovators have long experimented with eco-living and novel building designs, from ambitious projects like Paolo Soleri’s Arcosanti in Arizona, to the use of locally sourced building materials, large scale developers have been slower to adopt low carbon designs and new technologies. While real estate has often focussed on the bottom-line, only recently have leaders turned to examine the importance of ESG issues and their wider impact on society.
What’s going on?
The move to decarbonise can be an internal decision by a developer’s management team, but increasingly the winds of change are being driven by real estate’s institutional investors. ESG funds have grown in recent years, with European sustainable funds reaching a value of $1 Trillion 2020. The growth of ESG funds is partly linked to increased retail investor awareness, but more specifically, the adoption of ESG sustainability strategies by large institutional investors in response to initiatives like UNSDGs. For example, in 2018, Legal and General announced the alignment of its strategic priorities with UNSDGs. Investment mandates, screening and decisions, then turn to focus on a portfolio’s underlying assets: the buildings.The World Green Building Council estimates that 39% of global emissions originate from buildings and construction. Creating new assets generates 11% of the total through ‘embodied carbon’, integrated into the fabric of buildings through materials and construction processes. Once complete, 28% of operational carbon emissions emerge from building lighting, temperature control and energy needs.
New technologies to reduce carbon can be incredibly novel. For example, replacing embodied carbon in concrete with alternative materials like mycelium – ‘mushroom bricks’. More mainstream approaches by build-to-rent developers, for example, use energy recycling from air-conditioning to heat water, or smart building controls to drive energy efficiency. This reduces operational carbon and operational costs. Meanwhile, housing associations have found that micro generation reduces carbon emissions and energy bills for tenants. It would be incorrect to claim that all investors and operators are making a full pivot to ESG sustainability, far from it, as different funds have differing mandates and objectives. However, broadly speaking, investors are beginning to scrutinise investment opportunities more carefully, with an interest in the embodied and operational carbon emissions of new build and real estate acquisitions – and by extension, data.
Data – making carbon visible
Digital transformation in the sector has seen the increased digitization of buildings. However, when it comes to carbon-related data there are two main issues facing the sector. First, there is no industry-wide consensus or set of standards on what data should be used to measure a building’s level of ‘carbonation’. Second, owners and developers do not necessarily collect that data, or collect it in a way that is useful to investors. So why is the lack of data problematic? Green/sustainability/ESG are often used interchangeably and there are different variations as to what can be called a green or low carbon bond. For example, developers seeking to issue a ‘green bond’ may follow ICMA’s Green Bond Principles, or they may try to just ‘green wash’ a development as being ESG friendly through their own branding. Carbon data is increasingly important because financiers are beginning to offer cheaper financing for lower carbon assets. For example, UK housing associations have begun to issue bonds under a Sustainable Housing Label. Due to high demand from investors with ESG on their mind, some developers have been able to raise cheaper financing than fellow associations, if they can prove their low carbon credentials. To be able to demonstrate these credentials, data is needed to reassure investors and to establish accurate pricing – much more difficult when the carbon data available is opaque or unreliable.
What already exists?
Many institutional investors request ESG and carbon data from developers and asset owners as a pre-requisite to investment, but with the absence of a broader framework, each investor can request different types of data from one business, in different formats, which is increasingly placing an administrative burden on treasury teams, especially as investors are seeking more granular data. One attempt to address this issue has seen investors, housing associations and other stakeholders come together to create the UK ESG Social Housing Association working group, which has established a data framework, in an attempt to standardise requirements, while ensuring that it shows the sector in its best light. Another standard exists in the form of European consultancy Ritterwald’s Certified Sustainable Housing Label, which sees the third party evaluate if a housing business meets its standards. Again, this has been utilised in the UK, more by housing associations in the build-to-rent market, rather than private equity-backed developments or vertically integrated developers.
What are the risks of limited carbon disclosure?
The market is changing quickly, and as ever, it is both difficult and unwise to try to predict the future, but if a business does not have an adequate data infrastructure or dashboard to collect carbon data, there are potential risks it could face. For example, if long-term capital investors comfortable with lower yields, but with more of a focus on low carbon, become more prominent in the market, it may become more expensive for businesses to raise capital if they have not decarbonised their holdings, or do not have the data to demonstrate this. More broadly, a lack of data standards in the sector, could increase administration costs in providing carbon data to investors, which can be more time consuming if the data is not readily available. As appetite grows for low carbon real estate investments, this could in theory reduce demand for buildings with higher embodied or operational carbon. This could potentially reduce the value of higher carbon buildings in the future, if the aim is to sell on these assets at a later date, which may create more pressure to track the embodied and operational carbon in buildings. Data fidelity could also become important in the future to guard against the risk of fraud. For example, Volkswagen’s emissions scandal was effectively based on the manipulation of data and had substantial repercussions for the business. If real estate funding costs from investors are connected to carbon emissions, the data is audited and found to be inaccurate (accidentally or otherwise), could that trigger legal action or covenants? This scenario illustrates the important need to have clear and reliable carbon data and associated infrastructure, to protect all parties. Again, it emphasises the need for a common data infrastructure across the real estate sector.
What next? Calls to action…
Property developers and asset managers should ensure that they keep track of their carbon data and to ensure they have processes and systems in place to capture the information. Where possible, it could be useful to benchmark and collect data aligned with competitors and sector leaders to understand the business’ carbon trajectories and what mitigations could be taken to reduce carbon. Ideally, this should consider operational and embodied carbon. As interest in low carbon real estate assets continue, developers could consider more ambitious low carbon technologies for new build assets, to reduce embodied and operational carbon. This may not always be possible, but it is useful to track the impact of low carbon technologies where possible and potentially retro-fit interventions to reduce operational carbon. Above, we highlighted the need for common data standards to compare carbon performance between buildings and businesses in the sector, to enable transparency, and more accurate finance pricing that takes carbon into account.
Rather than reinvent the wheel, it may be useful to build upon existing standards across the entire sector. For example, private equity-backed BTR could adopt and align with UK ESG Social Housing Standards to add potential for comparability. The standards may not completely align due to different focusses of the businesses in the market, but could enable clearer comparisons, while reducing the burdens of supplying different standards of data to different investors. This need not necessarily be about enhancing standards, but rather providing a sector wide framework to enhance carbon transparency. This could be useful to investors to assist in funding pricing, or to promote carbon credentials as a value proposition to tenants. In a recent project, stakeholders announced that tenants may not be necessarily willing to pay more, but they would recognise a low carbon development over another as an attractive value proposition in their decision-making.
The need for carbon data change can be seen as an opportunity, rather than a burden. Rating agencies are moving to benchmark all businesses based on their ESG credentials and the sector could take the lead in showcasing its particular carbon credentials, by developing its own data framework, rather than trying to fit into a benchmark or rating system associated with other industry sectors. This requires leadership in the sector, but the growing interest in carbon and real estate is certainly here to stay.
Methodology: The data collected to underpin this research project consisted of expert interviews with 50 prominent actors within the UK’s real-estate sector. This was supported through secondary resources and publicly available materials.
Acknowledgements: Comments from reviewers are much appreciated in clarifying and augmenting the key points raised in earlier drafts.
 https://ukcop26.org/  https://sdgs.un.org/goals  https://www.worldgbc.org/thecommitment  https://en.wikipedia.org/wiki/Arcosanti  https://www.gov.uk/government/publications/construction-labour-market-in-the-uk-farmer-review  https://www.morningstar.co.uk/uk/news/207071/whats-driving-the-rise-in-esg-funds.aspx  https://www.legalandgeneralgroup.com/media-centre/press-releases/legal-general-s-business-priorities-aligned-to-the-un-sustainable-development-goals/  https://www.certifiedenergy.com.au/emerging-materials/emerging-materials-mycelium-brick  https://www.icmagroup.org/sustainable-finance/the-principles-guidelines-and-handbooks/green-bond-principles-gbp/  https://esgsocialhousing.co.uk/  https://www.sustainable-housing.eu/  https://en.wikipedia.org/wiki/Volkswagen_emissions_scandal